Application of Porters Five Forces on Construction Sector - Research Paper Example

Application of Porter’s five forces on Construction Sector Introduction The construction industry is a booming industry around the world and at present it is providing lots of opportunities to the leading construction companies for the growth of their business. The developing countries are attracting the leading construction companies with their booming market environment. Moreover, they are providing international technologies in infrastructure building of developing nations. This in turn creates a globalized business environment in their countries. The construction industry is usually urban-based industry as the major construction works happen in the urban areas. The work includes building of roads, bridges and other major infrastructures. The real estate business is also urban based; so the constructions companies need to base all their business activity in urban areas in order to compliment the real estate industry. The repair and maintenance of existing buildings and other infrastructures also falls under the domain of construction industry and its major business comes from the densely populated urban areas. This is due to the fact that the more usage of infrastructure in densely populated urban areas results in higher damages and hence is subject to repair. There are mainly three categories in which the construction industry is divided. First, being the heavy constructions that require high civil engineering; in this category we have the construction of roads, bridges and other big infrastructures. In this category the big guns of construction industry come into function for all major commitments. The second category is the general construction of buildings of real estate; in this category the construction companies operate in housing development works. The small construction companies mainly operate in this category, as it requires small budgetary involvements. The third and final category comprise of special constructive work, which is done in small scale. Specialized areas of construction fall in this category like the construction work on wood, electric related works, etc. In this category very specific construction companies operate as it require specialization in specific field of work. (Economy watch, n.d). It is seen that the contractor may be an individual or any organization; contractors definitely fall in any of the above categories in construction business. A construction firm, of any size can fall under these three categories of the construction business. The scope of growth of construction industry is favorable in the developing countries where the trend of economic growth is experiencing a positive rise. The prospects in house building or any other private non-residential buildings are looking to be promising in the coming years. Hence, the opportunity of growth in the construction business is influencing lots of companies to enter the construction industry in near future. We further analyse the prospects of construction industry with the application of Porter’s five forces subject to two leading construction companies, Balfour Beatty and Carillion. (DM Economic Consultant, September 2006). Porter’s five force analysis Here we will analyze the future prospect of the construction industry with the help of Michael Porter’s model of five forces in context with the two leading construction companies in construction business of UK. The Porter’s analysis deals with five forces namely, threat of new entries, threat of substitute products and services, bargaining power of the supplier, bargaining power of the buyer and rivalry among existing competitors. So we discuss the effects of these five forces in the context of construction industry and civil engineering. (Porter. M, 1979, 79-93); (Porter. M. E, Kramer. M. R, December 2006, 81-92) Rivalry among existing competitors In the construction industry, the rivalries among the existing competitors are quite prominent; the competition among them results in the healthy growth of the industry. The large firms in the construction industry always compete among themselves over the tenders and contracts of huge projects and for this they are bound to quote speculative low prices as the cost of the project. Quote price becomes the point of competition among the large firms and as a result they often end up earning minimal profits. The experienced large firms stand a high chance of securing the tenders with their knowledge and expertise but it’s not possible for a new or a small firm. Thus competition and rivalry exists among the leading firms only for getting large jobs but ultimately they end up earning low profits. So, one may think why would the large firms compete so much to gain such low profits. This is because the large firms are market leaders and they opt to do this kind of large jobs to gain good reputation in the market that will secure their position in the long run. (Corporate watch, n.d) From the civil engineering point of view, there is rivalry among existing competitors and their work performance will be the deciding factor of their survival. The rivalry mainly exists if the players are of same size and they have comparable strategies. That is, if the players follow similar strategies in the civil engineering works then there is scope for rivalry as others will try to modify their strategies and attract the customers with some additional benefits. Thus it becomes a rivalry point of who is going to provide more additional benefits in terms of holding the interest of buyers. There is also rivalry among the existing players if the exit barrier is high in the industry and survival is becoming difficult with presence of high number of players. (Economy watch, n.d) Threat of new entries In any industry, the existing players always feel the threat of new companies entering the market and sharing their profits. The construction market also falls in the same category. High growth and good future prospects of the business always attract the entrepreneurs to enter into construction business. With the huge infrastructural developments happening around the world the demand for services in construction industry is very high. This high market demand encourages new players to penetrate the industry with profit making objective and provides direct threat to the existing players. (Corporate watch, n.d) From the point of view of Civil engineering industry, it can be seen that owing to the high potential of building strong economy there are lots of multinational companies and civil engineers who are opting to get into the industry providing threat to the existing players in the industry. With the development of society and the global technological advancement there is lot of positive prospect of growth in the civil engineering industry which is a major attraction for new players to enter the industry. (Economy watch, n.d) Threat of substitute products and services In the construction industry, there is not much threat of substitute product or services because in case of the three categories of construction business, which are discussed above, all the associated services are covered up. Hence, initialization of any new substitute might not be helpful for companies. There are constant developments in the services of construction industry, which will not allow any substitute to capture the market demand. The leading companies of the construction industries who fall under the first category of construction business are providing all the services related to construction so; there is no real threat for them with substitutes entering the market. (Corporate watch, n.d) From the civil engineering industry’s point of view, the threat depends on the other products and services that are available in the market. If similar service is available at lower comparative price then that leads to major threat in terms of substitution. In the civil engineering industry many firms operates with similar services and there relative prices are the major concern in this aspect. Hence, the prices for similar services should be similar in the industry to eliminate the threat of substitute products and services. (Economy watch, n.d) Bargaining power of supplier In the construction industry, the bargaining power of suppliers implies the high cost of construction and its related product and services. Powerful companies quote the high prices of products; these business leaders highly influence the market prices. The market demand of products and services related to construction industry also influence the change in prices. The consumers get bound by the power of these market leaders and accept the high prices of these product and services. Thus the bargaining power of the global leaders in the construction business is justified owing to the high market demand for their services. (Corporate watch, n.d) From the civil engineering point of view, the bargaining power of suppliers largely depends on the goodwill and reputation of the firm. If a firm had acquired a brand name in the market then it has bigger power to influence the prices of products and services in the market. The bargaining power in the civil engineering industry is also subject to the number of firms present in the market, that is, if there are only few firms operating in the market then they have the power of influencing the market price of the products and services. (Economy watch, n.d) Bargaining power of the buyer In the construction industry, the bargaining power of the buyers is also high especially in case of housing construction by individual contractors. The buyers tend to bargain owing to the high profit making strategies of the suppliers. Thus it is said to be the flip side to the bargaining power of suppliers in Porter’s analysis. The buyers in the construction industries influence the prices by threatening to change the contractor; due to the growth of construction business there are new contractors who at low price may provide good quality service to grab the customers. Thus the bargaining power of buyers has fair bit of influence on the small-scale constructions. For the contracts of the heavy construction, tenders are issued and the company quoting lower price secures the contract, which is another way of showing bargaining power of the buyers. In this case buyers are generally high profile companies or Governmental bodies and they only deal with the big guns of construction business. (Corporate watch, n.d) From the civil engineering point of view, the bargaining power of the customers depends on various aspects. Firstly, a customer has larger bargaining power if he buys the product or service at large volume. Secondly, the customers tend to compare the prices with other similar products available in the market if he is well informed about the market prices. If the other services are provided at lower prices then the customer tends to bargain and eventually influences the price of the product or service in the civil engineering industry. (Economy watch, n.d) Overview of the two companies – Balfour Beatty and Carillion Balfour Beatty Balfour Beatty is a construction contractor who deals with wide range of services in building construction, civil engineering, facilities management, renovations, etc. It’s an UK based company but operates all over the world and has subsidiary bodies in America, Asia, Middle East, Europe, etc. The company provides vast range of services in the field of infrastructure management and maintenance and other professional and technical services. These services accommodate with transport, education, health, water and power sector. According to the Annual Report 2006 of the company, the company experienced a growth of 19% in its revenue generation owing to its mergers and acquisitions. The future of the company is looking good with the high rate of increase in its revenues. The growth is subject to the demand of construction in UK and the growth of other supportive sectors in UK. The operational profit of the company before the amortization of intangible and exceptional assets rose from ₤115 million to ₤144 millions in that financial year which is about 25% increase in one year. This outstanding rise in profit shows not only the growth structure of the company but also the development of the construction industry in UK. The company had also experienced growth in the investment sector and rail sector with significant profits and created a strong goodwill for itself in the market with its good performance. The company also benefited in the year 2006 by strong cash flows in its operations with improvement in companies’ working capital management. (Global Markets Direct – Company Reports, September 02, 2009). Carillion Carillion plc is another UK based construction company. This company is considered as the major rival of Balfour Beatty with similar sort of business in the same constructional sector. This company also comprises of wide range of services in construction of buildings and their repairs and maintenance. The company also provides consultancy services in constructions along with project financing and facilities management. Their services cater to similar sectors like that of Balfour Beatty and hence stand as a main competitor in the construction business in UK. (Annual Reports and Accounts 2006, March 7, 2007). In accordance to the analysis of the 2006 Annual report of this company, owing to its mergers and acquisitions the company experienced a whooping 57% increase in its revenue generation. This figure is way above Balfour Beatty. Hence according to the report the future prospect of the company is shining bright. The operational profit of the company before amortization, increased by about 48% from ₤55.5 million to ₤82.1 million in that financial year, which is also way above than Balfour Beatty. But the volume of profit is more for Balfour Beatty in considering its bigger market structure. The data shows that Carillion being a comparatively smaller company than Balfour Beatty is giving the latter a tough competition in the construction business. It also had experienced strong cash flows in its operations that helped the company to generate this type of phenomenal success. The authority had promised of same type of commitment and professionalism by the employees in the future, which is a good sign of future prosperity and development in the construction business. (Rogerson, March 7, 2007). Conclusion From the above analysis of construction industry and the two firms, Balfour Beatty and Carillion with the help of Porter’s five forces it can be said that the profits in the industry is mainly affected by the power of bargaining of the buyers and rivalry among the existing competitors. The bargaining power of the buyers makes the constructing firms quote low cost price for their services and products and for rivalry among competitors, the firms are forced to lower their prices to survive the competition. In both the cases, firms earn low profits and are worst off. The other three forces do not affect the performance of the firms in the construction industry. The bargaining power of the suppliers enables the large firms to quote high prices for their services in case of small jobs but for the large tenders their strategies are different. The threat of new entrants and the threat of substitutes do not quite affect the work performance of the established firms in the construction industry. References 1. Annual Reports and Accounts 2006, (March 7, 2007), Highlights, Carillion plc. Available at: http://www.carillionplc.com/investors/investors_annual_report_2006.asp (accessed on December 18, 2009) 2. Corporate watch (n.d), UK construction industry overview, Corporate critical research. Available at: http://www.corporatewatch.org/?lid=277 (accessed on December 18, 2009) 3. DM Economic Consultant (September 2006), Review of the construction industry 2005 and outlook 2006 to 2008, DM Economic Consultant Ltd. Available at: http://www.environ.ie/en/Publications/StatisticsandRegularPublications/ConstructionIndustryStatistics/FileDownLoad,1763,en.pdf (accessed on December 18, 2009) 4. Economy watch (n.d), Construction industry, Economy, Investment & Finance Reports, Stanley St Labs. Available at: http://www.economywatch.com/world-industries/construction/ (accessed on December 18, 2009) 5. Global Markets Direct – Company Reports (September 02, 2009), Balfour Beatty plc- Financial and Strategy Analysis Review, the alacra store. Available at: http://www.alacrastore.com/storecontent/Global_Markets_Direct_Company_Reports-Balfour_Beatty_plc_Financial_and_Strategic_Analysis_Review-2087-773 (accessed on December 18, 2009) 6. Porter. M. E, (1979), The five competitive forces that shape strategy, Harvard business review. 79-93. (accessed on December 18, 2009) 7. Rogerson.P (March 7, 2007), Chairman’s statement, Annual reports and accounts 2006, Carillion plc. Available at: http://www.carillionplc.com/assets/documents/report2006.pdf (accessed on December 18, 2009) 8. Porter. M. E, Kramer. M. R, (December 2006), the link between competitive advantage and corporate social responsibility, Strategy and Society, Harvard Business review. 81-92. (accessed on December 18, 2009) 9. Economy watch (n.d), Civil Engineering industry, Economy, Investment & Finance Reports, Stanley St Labs. Available at: http://www.economywatch.com/world-industries/engineering/civil.html (accessed on December 18, 2009) Read More